The roughly 350 independent marketing organizations thatdistribute fixed indexed annuities will need considerable cash onhand to operate as financial institutions under the Labor Department’s fiduciary rule.

Labor released a proposed class exemption that would qualifyIMOs as financial institutions under the rule’sBest Interest Contract Exemption. The financialinstitution designation is required to sell commission-basedinvestments like FIAs to IRA investors.

As proposed, the exemption requires IMOs to have sold at least$1.5 billion in FIA premiums in each of the last three fiscalyears.

They will also need 1 percent of the average amount of premiumsales over three years set aside in cash, bonds, and fiduciaryliability insurance.

That means an IMO that meets the $1.5 billion sales thresholdwould need $15 million in cash reserves and insurance policies toqualify as a financial institution.

In crafting the class-wide exemption, Labor considered theapplications of 22 IMOs. Some disclosed their revenues toregulators.

The proposal says those that did “generally indicated” premiumssales of $1.5 billion or more.

Under the proposed sales and reserve requirements, it ispossible that no IMOs would be able to qualify as a financialinstitution, says Sheryl Moore, (pictured) CEO of Moore MarketIntelligence, which provides analytics tools to the insuranceindustry.

“Given what the DOL knew about the revenues of the applicants,you can’t tell me they didn’t know the $1.5 billion sales thresholdwill obliterate the IMO distribution channel,” said Moore.

Of the approximately 350 IMOs operating throughout the country,Moore estimates that perhaps 12 could comply with the $1.5 billionrevenue threshold. Of the 22 IMOs that applied for individualexemptions to the Labor Department, she says maybe one-third meetthe revenue requirement.

Even the handful of IMOs that meet the $1.5 billion thresholdwill struggle with the 1 percent cash reserve requirement, saysMoore.

“How many IMOs do you think have $15 million in the bank? Iwould say one, two at the very most,” said Moore.

“The reserving requirements will create a monopoly in themarket,” she added. “I’m not sure DOL really cares that this willmean IMOs will wither on the vine.”

Labor’s reasoning

In its lengthy proposal, much of which is a rehash of thefinalized fiduciary rule, the Labor Department said the inherentcomplexity of FIAs warrants the high bar it has proposed for IMOsto qualify as financial institutions.

“In the Department’s view, the complexity and conflicted paymentstructures associated with fixed indexed annuities heighten thedangers posed by conflicts of interest when advisers recommendthese products to retirement investors,” according to language inthe proposal.

The proposal acknowledges the role IMOs play in providingmarketing, and in some cases, compliance support to independentinsurance agents. It also suggests IMOs will be able to continue tooperate in the market without qualifying for the financialinstitution exemption by contracting with insurance companies tohelp distribute FIAs to the independent agent channel.

In proposing the $1.5 billion threshold, the Departmentquestions whether IMOs below that level of sales have the resourcesto adequately monitor conflicts of interests in thecommission-based marketplace, “particularly without the history ofoversight and supervisory experience that characterize otherfinancial institutions, such as banks, insurance companies, andbroker dealers,” the proposal says.

“Labor has a point—they are insecure over the fact that IMOsdon’t have a regulatory body,” said Moore. “But the reality is thethresholds they set may leave no IMOs with the ability tocomply.”

Labor asks for more information from IMOs

The Labor Department has opened a 30-day comment period on itsproposal, which closes on February 18. The Department is proposingmaking the exemption available on April 10, the firstimplementation date for the fiduciary rule, but is offeringtransitional relief for IMOs through August 15, 2018.

Among the areas of clarification it’s seeking, Labor is askingfor more information on carriers’ ability to change the terms ofFIA contracts during the life of an annuity. The Department isconsidering limiting the financial institution exemption to thesale of FIA that don’t materially change the terms ofcontracts.

“Odd” timing

Doug Meyer, managing director at Fitch Ratings, also thinks theproposed thresholds are unrealistic for IMOs.

“Given how IMO revenues are configured, they are going tostruggle with this,” he said.

There is a silver lining for IMOs. “We see the rule gettingdelayed and ultimately revised under the Trump administration,”said Meyer. “I would expect these capital requirements for IMOs tobe part of those revisions,” he said.